Monday, January 7, 2013

Ryan Murphy has a short paper out at the Beacon Hill Institute on state-level fiscal policy. Much of the paper is a discussion of supply-side and then demand-side determinants of unemployment. The state policy discussion seems to motivate the paper, and then come back in at the end.

I was intrigued by the attribution of up to a 2.7 percent increase in the unemployment rate to unemployment insurance in the supply side discussion (he also talks about lower estimates). I thought the estimate was much lower, but I don't know the literature (and it's not clear what study produced the 2.7 estimate). Most of this section is about lowering the NAIRU, which is always nice but not at the top of my list during a depression.

I was a little surprised to see this sentence in the demand-side discussion (he is referencing sticky wages): "these (or very similar) problems must be present for there to be unemployment caused by the demand side". Sticky wages and prices give us a reason for thinking that the short run aggregate supply curve to be upward sloping. They also may explain why the labor market doesn't clear (or maybe they don't, if you just figure that observed sticky wages are a function of a relatively elastic labor demand schedule). But it doesn't seem right to me to say that you need sticky wages for unemployment due to weak demand.

It's bothered me for a long time that people associate unemployment with a surplus in the labor market. If you think about our definition of "unemployment", it has nothing at all to do with reservation wages or whether the labor market fails to clear. To be "unemployed" you simply have to want a job but not have a job. In other words, a clearing labor market with low aggregate demand and therefore low labor demand is going to generate what the Bureau of Labor Statistics counts up as "unemployment" and which we very much care about as "unemployment".

The crux of his argument against state fiscal policy, which appears after the demand section, is that states do not have the power of the printing press, and therefore pay higher interest rates and risk bankruptcy in a way that the federal government doesn't.

I suppose I see where he's going with this, but this doesn't really make sense to me. State and municipal bonds are denominated in dollars just like federal bonds. The Fed doesn't just cancel the federal debt - it inflates it away (potentially), but this is something that states and localities can benefit from as well. I'd think one point we could make is that revenue is more volatile at the local level than at the federal level, and combined with higher borrowing costs this can put localities in a bind.

I've noted on here before that I wish states and localities did more stimulus, both to reinvigorate federalist principles and because it is precisely sub-national government that is the biggest drag on recovery. If I had to think up risks of that approach it wouldn't be that the Fed is a national institution. That seems entirely irrelevant since all these debts are denominated in dollars. It would be that state economies are far more open than federal economies, so you would need coordination of this sort of effort.

I think 1.0 percentage point should be attributed to unemployment insurance myself. Immediately after mentioning the 2.7 percentage points, I immediately cite a paper disputing Barro.

There are other possible reasons for demand-side unemployment like monopolistic competition or whatever but a) I don't see why that changes the policy conclusions b) this is a paper for the educated public and sticky wages are easiest to explain and c) sticky wages are the most universally accepted reason. "Or very similar" stated parenthetically was meant to address this.

Now that I've had a couple minutes to think about, this is how I would respond. Bankruptcies have happened before at the subnational level, even though the debts were denominated in dollars. Regarding Federalism, I would prefer the *decisions* of how fiscal stimulus dollars be spent to be made by the states, but the stimulus dollars must first come from Federal government. During a recession, I also think public savings of these dollars is a good thing (though not to excess obviously) to avert later need for austerity. It's certainly what California should do with an infusion of money, for example.

But the underlying point to the entire paper is that jobs shouldn't enter the cost-benefit analyses of states. If there is no need for public savings and the Federal government gives the state money, it should tick down the list of projects that will produce the most surplus, ignoring the number of jobs the proponents of specific projects will argue their projects will create. In other words, you still can't justify building a wind turbine.

Balanced budget requirements are based on federalist principles. They are after all a part of most state constitutions (indeed, South Dakota was the latest state to ratify such a provision by referendum in the 2012 election) and have been unfolding as a part of such since the late 19th century. I'm curious if this is the tail end of the reaction to the wave of state bankruptcies in the 1870s and 1880s.